This Tax Alert highlights key aspects of the IDT Rules.

Transcription

1 30 June 2016 EY Tax Alert Indian Administration issues indirect transfer rules Executive summary Tax Alerts cover significant tax news, developments and changes in legislation that affect Indian businesses. They act as technical summaries to keep you on top of the latest tax issues. For more information, please contact your EY advisor. The Central Board of Direct taxes (CBDT), the apex administrative body for direct taxes in India, has recently issued [1] rules and forms in relation to the indirect transfer (IDT) provisions of the Indian Tax Laws (ITL). This is subsequent to the draft indirect rules released on 23 May 2016 for public consultation [2]. The ITL provides for taxation of IDT in India. The IDT provisions provide for taxation of gains arising from the transfer of share or interest in a foreign company (FCo) or foreign entity (FE) whose value is derived, directly or indirectly, substantially from assets located in India. The IDT provisions were further amended in 2015 to deal with certain specific aspects like the substantiality threshold of 50%, taxation on proportionate basis i.e., to the extent of value of India assets, reporting obligation relating to IDT transactions, small shareholder exemption etc. Pursuant to the above, the CBDT has now issued rules and forms as required under the ITL (IDT Rules). The IDT Rules provide for valuation mechanism, determination of proportionate income, forms for reporting compliance and details of documents to be maintained by the Indian concern in respect of IDT transactions. These IDT Rules come into force from 28 June This Tax Alert highlights key aspects of the IDT Rules. [1] Notification No. 55/2016 dated 28 June 2016 [2] Refer EY Alert dated 24 May 2016 titled Indian Tax Administration issues draft indirect transfer rules; invites comments from stakeholders

2 Background IDT provisions of the ITL In 2012, the ITL was amended to introduce the IDT provisions. The IDT provisions provide for taxation of gains arising from transfer of share or interest in an FCo or an FE whose value is derived, directly or indirectly, substantially from assets located in India. The IDT provisions were further amended in 2015 to clarify/provide for some specific aspects like 50% threshold to ascertain substantial value from assets in India, taxation on proportionate basis i.e., to the extent of value of India assets, reporting obligation on Indian concerns to furnish information/documents relating to IDT transactions etc [3]. In terms of the IDT provisions, the CBDT is empowered to prescribe rules for determination of valuation of assets, income which is attributable to India-located assets and the reporting mechanism. IDT Rules 1. Rules on determination of FMV of assets (Rule 11UB) The ITL provides that shares or interest in FCo/ FE would derive its value substantially from assets in India if the value of such Indian assets represents 50% or more of the value of all assets of the FCo/ FE [4]. Furthermore, the value of the Indian asset shall be based on its FMV on the SD, without reduction of liabilities, if any, in respect of the assets. Such FMV needs to be determined as per the prescribed rules. Pursuant to the above, the CBDT has now issued the IDT Rules and forms which include: Valuation norms, based on the fair market value (FMV) of assets, without reduction of liabilities in relation to these assets in order to determine substantiality threshold of 50%. Determination of proportionate income attributable to India assets based on FMV of assets as on the specified date (SD). Information/documents to be maintained and furnished by Indian concerns in relation to IDT transactions. [3] For details, refer EY Global Alert titled India releases Budget 2015 dated 5 March 2015 [4] This is in addition to condition of value of Indian assets to exceed INR100m to trigger IDT provisions.

3 FMV of asset, tangible and intangible held, directly or indirectly, by an FCo/FE Sr. No. Type of asset Method of determining FMV Valuation by 1. Asset being share of a listed Indian company (without any, direct or indirect, right of management or control in the company) 2. Asset being share of a listed Indian company (which is part of holding which confers direct or indirect right of management or control in the company) 3. Asset being share of an Indian company which is not listed on a recognized stock exchange, as on the SD Observable price [5] on stock exchange (Market capitalization based on observable price [5] Book value of liabilities [6] on SD) Total number of outstanding shares FMV as on the SD determined in accordance with any internationally accepted valuation methodology for valuation of shares on arm s length basis N.A. N.A. Merchant banker [7] or an accountant [8] 4. Interest in a partnership firm [9] or association of persons (AOP) Liability, if any, considered in such determination Step 1: Determine the value of firm or AOP as on the SD in accordance with any internationally accepted valuation methodology Liability, if any, considered in such determination Step 2: Value determined in Step (1) above is allocated among partners or members in following proportion: (a)first, capital contribution amount; (b)residual [remaining post part (a) allocation] -Distribution of assets upon dissolution of the firm or AOP, in accordance with the agreement; -Profit sharing ratio, in absence of an agreement FMV of the interest of a partner/member in the firm/aop = (a) (b) Merchant banker [7] or an accountant [8] 5. Any assets other than the above Price if sold in the open market on the SD Liability, if any, considered in such determination Merchant banker [7] or an accountant [8] Sr. No. FMV of all the assets of FCo/FE: Type of asset of F Co/FE Method of determining FMV Valuation by 1. Asset being share/interest in F Co/FE and transfer is between not connected parties [10] Market capitalization based on full value of consideration for transfer of the share or interest Book value of liabilities [6] on SD as certified by a merchant banker [7] or an accountant [8] or a foreign accountant/valuer [8] N.A. 2. In any other case (i.e. when transfer is between connected parties) [10]

4 (a) Asset being share of FCo/FE, listed as on the SD (Market capitalization based on observable price [5] Book value of liabilities [6] on the SD) N.A. (b) Share of FCo/ FE, are not listed on a recognized stock exchange as on the SD FMV of FCo/ FE as on the SD, determined as per the internationally accepted valuation methodology Value of liabilities of FCo/FE considered for the determination of FMV Merchant banker [7] or an accountant [8] or a foreign accountant/valuer [8] Note For determining the FMV of any asset located in India, being a share of an Indian company or interest in a partnership firm or AOP, all the assets and business operations of the said entity shall be taken into account irrespective of whether the assets or business operations are located in India or outside. Value of assets located in India and expressed in rupees shall be calculated in foreign currency using TT buying rate [11] of such currency as on SD. 2. Rules to determine income attributable to assets in India (Rule 11 UC) Under the IDT provisions of the ITL, only that income of a non-resident transferor which is reasonably attributable to the assets located in India, shall be taxable in India. Such reasonably attributable income is to be determined as may be prescribed [5] Refer Note (i) below. [6] Refer Note (ii) below. [7] Refer Note (vi) below. [8] Refer Note (vii) below. [9] Includes limited liability partnerships (LLP) [10] Refer Note (iv) below. [11] TT buying rate in relation to a foreign currency, means the rate or rates of exchange adopted by the State Bank of India. As per the notified rule, reasonably attributable income is the proportionate amount of such income from transfer of shares or interest in FCo/FE, basis the FMV of India assets and global assets of the FCo/FE as on the SD, in accordance with the following formula: A Where: x B C A = Income from the transfer of the share or interest in FCo/FE in accordance with the ITL as if such share or interest is located in India B = FMV of assets located in India as on the SD, determined as per Rule 11UB C =FMV of all assets of FCo/FE as on the SD, determined as per Rule 11UB If transferor fails to provide the information required for application of aforesaid formula, the income attributable to assets located in India shall be determined by the Tax Officer in a suitable manner. Transferor is required to furnish an audit report (in Form 3CT) along with the return of income, providing the basis of apportionment of income.

5 In Form 3CT, an accountant [8] is required to verify the following details (company/ entity wise) in relation to the transfer and the income attributable to India: Details of transfer like date of transaction, quantum of share or interest transferred, cost of acquisition of share or interest, the consideration amount etc. Income derived from transfer of share or interest of an FCo/FE, calculated in accordance with the ITL provisions. Value of India assets and global assets of FCo/FE (including details of valuation report and the valuation method employed). Income attributable and details of the method employed for computation. Details of the documents and valuation report, if any, relied upon. Remarks, including any assumptions made. The accountant is required to state the reasons for any negative remarks or any qualification in respect of any matter in the report 3. Rules regarding reporting of information and documents by the Indian concern Under the ITL, where a share or interest in an FCo FE derives its substantial value from assets located in India and such FCo/FE holds, directly or indirectly, such assets in India through or in an Indian concern, then, such Indian concern shall furnish information or documents, as prescribed by the CBDT, for the purposes of determination of any income accruing or arising in India under the ITL provisions.

6 IDT rules provide for the following: Applicability: An Indian concern through or in which the FCo/FE derives, directly or indirectly, its value substantially. Where there are more than one Indian concerns that are constituent entities of a group [12], the information may be furnished by any one Indian concern, if: The group has designated such Indian concern to furnish information on behalf of all other Indian concerns. The information regarding the designated Indian concern has been conveyed in writing on behalf of the group to the Tax officer [13]. Mode of furnishing: The information is to be furnished in Form 49D electronically under digital signature. Whom to furnish: The Tax Officer having jurisdiction over the Indian concern. Due dates: Nature of Transfer Time limit Penalty in case of failure [14] Transfer has effect of, directly or indirectly, transferring the rights of management or control in relation to the Indian concern 90 days from the date of transfer 2% of the transaction value Other cases 90 days from the end of the financial year (FY) in which transfer takes place INR 5,00,000 Information to be furnished The following particulars are required to be furnished in Form 49D, which can be divided into three parts as follows: Part Nature of information Particulars Part A Basic details -Name, status, residential status, Permanent Account Number of the designated Indian concern and other constituent Indian concerns -Details of immediate, intermediate as well as ultimate holding entity, Part B Part C Information in respect of transfer if it results in transfer of right of management or control Information in respect of transfer of share/interest during the previous year -Name of FCo/ FE, its Financial and accounting statements -Details of the transactions including consideration, details of transferor/ transferee -% share/interest transferred including % holding of transferor during the period of 12 months preceding the transfer -Holding structure in respect of shares/ interest before and after the transfer -Basis of determining the location of share/ interest being transferred -Value and break-up of assets of the Indian concern immediately before the date of transfer -Basis of valuation of assets of the FCo/FE -Name of FCo/ FE -Details of the transactions, transferor, transferee -% share/interest transferred including % holding of transferor during the period of 12 months preceding the transfer -Value of total assets of FCo/ FE -Value and breakup of assets of the Indian concern, - (i) At the beginning of the year

7 (ii) At the end of the year -Basis of valuation of assets Also, where transfer has effect of transferring right of management/ control over Indian concern, following additional information is required: -Details of reporting compliance or reasons for non-compliance -Holding structure in respect of shares/ interest before and after the transfer -Financial and accounting statements of FCo/ FE -Basis of determining the location of share/ interest being transferred -Value and break-up of assets of the Indian concern immediately before the date of transfer Documents to be maintained by Indian concern [for eight years from the end of the relevant assessment year (AY) in which transfer takes place]: Details of the immediate, intermediate, as well as the ultimate holding company/entity of the Indian concern. Details of other Indian group entities. Holding structure of the shares/interest in FCo/FE before and after the transfer. Transfer contract or agreement. Financial and accounting statements of FCo/FE for two years prior to the date of transfer of the share or interest. Information relating to the decision or implementation process of the overall arrangement of the transfer. Information in respect of the FCo/FE and its subsidiaries relating to the business operation, personnel, finance and properties, internal and external audit or the valuation report. Asset valuation report and other supporting evidence to determine the place of location of the share /interest being transferred. Details of payment of tax outside India in respect of transfer of the share/interest. Valuation report in respect of Indian asset and total assets duly certified by a merchant banker [7] or an accountant [8], with supporting evidence. Documents which are issued in connection with the transactions under the accounting practice followed. [12] Definition of constituent entity and group is as per provisions in ITL on Country-by-Country Reporting [13] If the designated Indian concern fails to furnish the information, this sub-rule (allowing any of the Indian concerns to furnish information) shall not apply [14] As per ITL provisions. 4. Notes: (i) Meaning of observable price : In respect of a share quoted on a stock exchange shall be the higher of the following:- The average of the weekly high and low of the closing prices of the shares quoted on the said exchange during the six-month period preceding the SD; or the average of the weekly high and low of the closing price of the shares quoted on the said exchange during the two weeks preceding the SD; In cases where the share is listed on more than one recognized stock exchange, the observable price of the share shall be computed with reference to the recognized stock exchange which records the highest volume of trading in the share during the period which is considered for determining the price. (ii) Book value of liabilities means value shown in the balance sheet (BS), excluding paid-up capital of equity share or member s interest and the general reserves and surplus and security premium related to the paid-up capital.

8 (iii) Definition of BS: In relation to an Indian company: Audited BS (including notes) as drawn up on the SD. In other cases: BS (including notes) drawn up as on the SD and submitted to the relevant authority in which the FCo/FE is registered or incorporated. In the above cases, if on the SD, the BS is not drawn up and is pending finalization, then the BS shall mean the interim BS as approved by the Board of Directors of the company or an equivalent body in case of any other entity. Where FMV has been determined on the basis of any interim BS, then the FMV shall be appropriately modified after finalization of the relevant financial statement, in accordance with the applicable laws and all the provisions of the rules shall apply accordingly. Also, where the SD is the date of transfer, the BS shall mean the BS drawn up on such an SD and certified by an accountant. (iv) "Connected person" is defined as per the provisions in the General Anti-avoidance Rules (GAAR) (v) "Right of management or control" is defined to include the right to appoint the majority of the Directors or to control the management or policy decision exercisable by a person or persons acting individually or in concert, directly or indirectly, including by virtue of shareholding or management rights or shareholders agreements or voting agreements or in any other manner. of a company, also excludes persons who are not eligible to be appointed as an auditor of said company, in accordance with the Indian Corporate Laws. For valuation of shares of unlisted FCo/FE and/or certification of liabilities of the FCo/FE, the term accountant, in addition to Indian CA, also includes foreign accountant/valuer who fulfils the following conditions: Such accountant/valuer should be recognized by the Government (or its agencies) of the country where such FCo/FE is registered/incorporated for undertaking similar valuation. If such accountant/valuer is a member or partner of an entity rendering accountancy or valuation services, then such entity (or its affiliates) should have presence in more than two countries and the annual receipt of such entity preceding the year in which the valuation is undertaken should exceed INR100m (approximately USD1.48m) If such accountant is individually pursuing accountancy profession or is a valuer, then his annual professional receipts in the year preceding the year in which the valuation is undertaken should exceed INR10m (approximately USD0.148m) and he should have professional experience of not less than 10 years. (vi) The term merchant banker refers to Category I Merchant Banker registered with the Securities and Exchange Board of India (vii) Meaning of accountant : The term accountant refers to a Chartered Accountant holding a Certificate of Practice from the Institute of Chartered Accountants of India (Indian CA), but excludes such persons who are related to and/or have business relationship with the taxpayer, as prescribed under the ITL and in the case

9 Comments The IDT Rules were keenly awaited to provide much required clarity and certainty in taxation of IDT transactions in India. The detailed Rules cover the aspects of valuation, reporting and computation of taxable income in India. Keeping with the consultative approach adopted by the present Government, comments were invited from stakeholders on the draft IDT Rules. The final Rules make certain welcome amendments, such as accepting the transfer value as the basis for determining value of share /interest in FCo/ FE, when the transfer is between nonconnected parties; reporting compliance by a designated Indian concern to relieve other Indian concerns etc. The final Rules, however, continue to have a fair share of challenges. Illustratively, while the taxation is directed to be in proportion to assets located in India, the Rules provide that, in case of valuation of a share of an Indian company or interest in a firm or AOP, all assets and business operations of the company/entity (whether located in India or outside India) are required to be taken into account; the obligation on the Indian concern to maintain and furnish prescribed information is far too onerous and is not relieved even when the IDT may be exempt by virtue of the tax treaty applicability or small shareholder exemption provided under the ITL. The final Rules continue to require add-back of liabilities in determination of FMV, which, in most cases creates an anomaly, as the commercial valuation would be after considering the liabilities. Furthermore, the absence of clarity about the treatment of preference share capital or operating liabilities in this regard will add to complexity and litigation.

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